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A Cure Worse Than The Disease
Bas van Geffen

Yesterday’s data releases gave markets little reason to revisit the narrative from Wednesday’s FOMC minutes. Recall that these revealed about as hawkish of a hold as possible, given that some FOMC members had actually wanted to raise rates, before participants judged it “appropriate or acceptable” to hold. Particularly the latter does not sound like a ringing endorsement and is quite possibly the weakest support for the decision without actually casting a dissenting vote.

That hawkish read-across had already set the tone for the day before the ADP employment report counted 497,000 new jobs in June. Even after subtracting a -11k revision to last month’s estimate, that’s more than double the expected increase of 225,000. This was further corroborated by a strong ISM report for the services sector. Companies in the sector reported a rebound in hiring, on the back of a solid increase in current activity as well as new order inflows.

This resulted in sharp moves in both the rates and equities space. The US Treasuries curve bear steepened, with some 4bp increase in the 2-year segment versus 10bp for the 10-year note. European swings were even bigger: the 10y Bund closed 15bp up from the previous close. The steepening of both curves is particularly interesting as it suggests that markets may be reconsidering how long central banks will have to keep rates at peak, or how much room there will be for cuts afterwards, rather than simply revising up the estimate of peak policy rates.

And central banks may have to go further or hold rates at high levels for longer as long as the effects of rate hikes remain hard to see. In the US, credit conditions have been easing since the mini banking crisis. In Europe, financial conditions have tightened already, but the knock-on effects on the real economy remain limited so far. We have argued in the past that this may partly be the result of a decade of low rates, which has invited households and businesses to take on loans with longer fixed rate periods than before.

What’s more, the ECB is –to some extent– actively being undermined by European governments. The (often overly) generous compensation for high energy bills has been a thorn in the side of the central bank for months now, as it supported consumption demand, requiring further hikes to dampen activity. What’s more, several governments are now implementing policies that could limit the impact of additional monetary tightening.

The Italian government has made no secret of their opinion regarding the ECB’s rate hikes. Prime Minister Meloni acknowledged that “inflation is a hateful hidden tax” and that the ECB is right to fight it decisively. However, Meloni has openly questioned the ECB’s methods: “The simplistic recipe for rate increases undertaken by the ECB does not appear to be the most correct path … One cannot fail to consider the risk that the constant increase in interest rates is a more harmful cure than the disease.” Deputy Prime Minister Salvini went as far as calling the hikes “nonsense and harmful”asking“Does Lagarde have a variable rate mortgage? Do you know how much the instalments are increasing? Who benefits from these absurd decisions?”

Yet, the ECB flagged that it does not intend to stop here. So the Italian government is now looking at ways to ease the pressure on households with variable rate mortgages. Salvini told Rai radio on Tuesday that “we are working with the economy ministry to increase the number of instalments for people with a variable-rate mortgage,” and banks have expressed willingness to heed the government’s call. The president of the Italian Banking Association said it would be possible to extend the maturity of mortgages for those households who meet certain criteria, such as being current with mortgage payments.

The Italians are not the first to shield households from higher mortgage costs. In Spain, the government introduced various support measures for low income households. These range from grace periods to options to extend the maturity of the mortgage or to swap from a variable to a fixed rate, depending on the borrower’s situation. The Spanish relief comes with relatively high hurdles and strict conditions, so it certainly doesn’t eliminate all impact of rate hikes to date. Still, it does weaken the policy transmission somewhat. To what extent the Italian plans would hinder the ECB’s policy passthrough is unknown, as the exact details have yet to be worked out.

Nonetheless, it is a potential setback for the ECB. No measure will fully negate the impact of the hikes to date – households may still have to refinance to a higher, longer-term rate and maturity extension only lowers the monthly redemptions somewhat to compensate for the higher variable rates. That said, particularly the option to shift into longer-dated maturities could limit the impact of future rate increases. That, in turn, could force the ECB to do more than they would otherwise have to do, with potentially more devastating effects on the economy as a result. Doesn’t that make mortgage relief a cure that is worse than the disease?

At least measures are currently only being taken in countries like Spain and Italy, where inflation is relatively low compared to the bloc and where labor market tightness and, hence, wage pressures are less of an issue than in Germany and the Netherlands, for example. So while it impairs policy passthrough, it doesn’t hinder transmission in those parts of the Eurozone where it is most badly needed. Plus, at least governments aren’t taking out their check books – which would probably have been much more detrimental for price stability, and could have put government budgets under further scrutiny. Case in point are the plans announced by German Finance Minister Lindner earlier this week, which foresee a resumption of the debt brake in 2024, only €16.6 billion of additional debt, financed by significant spending cuts (nearly €32 billion) in many areas, but in particular with the health and family ministries.



Bas focus is on the European Central Bank, Eurozone and money markets.

Next to this, he is one of the analysts responsible for developing various models and indices used by the broader Financial Markets Research team.

Bas first joined Rabobank in 2009 as an intern and later as research assistant, before taking on a role as analyst in 2012. Bas is a CFA charterholder and he holds a master’s degree in economics from the University of Amsterdam, with a specialisation in monetary economics.

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